Have you been asked to provide a guarantee? Before you jump in you should take a moment to consider exactly what is at risk.
What is a guarantee?
A guarantee is an assurance given by one party (the guarantor) to another party (the beneficiary) that a third party (the guaranteed party) will comply with the terms of an arrangement between the beneficiary and the guaranteed party. Typically, this means that the guarantor will be liable to pay any amounts or perform any actions that the guaranteed party was required to pay or perform under the arrangement, where the guaranteed party fails to do so on time (or at all).
Who can give a guarantee?
Any adult person with capacity may provide a guarantee. A company may also provide a guarantee. Usually, a beneficiary will assess the financial standing of the guarantor when determining whether the guarantee is sufficient security to provide comfort to the beneficiary in the relevant circumstances.
When is a guarantee required?
A guarantee may be sought whenever the beneficiary considers the guaranteed party is at risk of not complying with the guaranteed arrangement. Guarantees are commonly required in commercial and retail leasing arrangements, trade supplier accounts and finance arrangements with commercial lenders.
What are the risks of being a guarantor?
The scope of the guarantor’s risk will depend on the terms of the guarantee document. Unless the guarantee is a limited guarantee (in time, to a dollar amount or to a set of actions), the beneficiary will be entitled to claim against the guarantor for all amounts that are or become owing under the guaranteed arrangement that the guaranteed party fails to pay, as well as any amounts required to be paid to rectify any other default of the guaranteed party (such as fees for paying an external party to perform tasks that the guaranteed party was required to complete).
By providing a guarantee, the guarantor exposes their personal assets (money in bank accounts, real estate, motor vehicles and other personal property) to risk of claims by the beneficiary. If the guarantor fails to pay a claim made under a guarantee, the beneficiary may be entitled to take court action to recover the amounts owing, plus interest and recovery costs. Even where a guarantee is limited to a dollar amount, that limit often carves out interest and recovery costs, which will quickly and significantly increase the bottom line for the guarantor.
Typically, a guarantee may also be accompanied by or contain an indemnity. An indemnity is a protection given by the guarantor to the beneficiary from all loss or damage that may be sustained as a result of the beneficiary entering the guaranteed arrangement, or the guaranteed party defaulting under that arrangement.
It is important to note that the beneficiary is often not required to sue the guaranteed party or exhaust any action against the guaranteed party’s assets before pursuing the guarantor. For example it will be more attractive for a landlord to claim against a guarantor with known assets than chase an asset-less tenant for an outstanding debt.
Also importantly, if you provide a guarantee together with another guarantor (such as 2 directors of a company guaranteeing the company’s performance as tenant under a lease) it is possible, and even probable (again dependent on the terms of the documents) that your liability will be joint and several, meaning that you and the co-guarantor will each be responsible for the whole debt (not just a proportionate share). The beneficiary may elect to pursue you solely for all outstanding amounts.
Can I get out of a guarantee?
A guarantor may be able to end a guarantee in accordance with its terms. Typically, this can mean that the credit or other services extended to the guaranteed party will be withdrawn or reduced, a replacement guarantor is procured or the other security arrangements are such that a guarantee is no longer required. It is extremely important to properly document the end of a guarantee and have the beneficiary acknowledge the release of the guarantor.